Unsentimental Journey

By way of reminder, it was June 23 when voters in Great Britain decided to go on permanent vacation from the European Union. Here we are nearly two week later, and the markets are still tallying up the winners and losers. According to the Wall Street TripTik, the S&P 500 lost 5% in two days post-Brexit while the NASDAQ backed up a swift 6%. Overseas, Japan’s Nikkei dropped 8% and France’s CAC fell 10%. Alan Greenspan, former chairman of the Federal Reserve, declared the Brexit vote “the worst period I recall since I’ve been in public service.”

During the 2013 “taper tantrum”, the S&P 500 dropped nearly 5% and then recovered the entire amount in 10 trading days

While it may appear the typically unruffled Fed chief was simply off his Dramamine, Brexit actually had a car-load of well-traveled investment professionals heading in the wrong direction. Part of the reason: Too many bet on the referendum outcome they preferred, not what the markets were telling them. It’s an emotional condition known to human market pickers as “projection bias.”

The China growth crisis caused the Dow to fall more than 11%, followed by a full recovery within seven weeks

Algorithms, on the other hand, aren’t, and weren’t, at all affected by such human sentiments. As a result, a relatively small number of customized trading models that didn’t factor in election polls, bookmakers’ odds, or political-tea leaf reading were, and will be, well-rewarded during the chaos.

The Greek debt referendum in 2015 caused an almost 12% pullback in the NASDAQ, which recovered in nine weeks

At this hour, despite all the Brexit bumpiness, most markets have crept forward to their first-quarter markers. Smart travelers will leave the windows rolled up to keep the noise out.

What the markets have been doing…

After Brexit concerns managed to push the major indexes to their lowest levels since early March, U.S. stocks rallied to generate solid gains for the period. The collective advance actually brought the S&P 500 nearly back to its level before Britain’s surprising vote to leave the European Union. All in, the markets’ net positive action left most of the major benchmarks with gains for the month of June and for the second quarter as a whole. Only the technology-heavy NASDAQ suffered overall, recording losses in both periods.

Growing confidence among investors that the implications of the Brexit vote. would only play out over the longer term seemed to help drive the rebound. Traders were also encouraged by a number of merger announcements and takeover bids, suggesting that the corporations were conducting business as usual in the wake of the vote. A bit of positive U.S. economic news, not least of which a jump in consumer confidence, also boosted sentiment later in the period.

Index

Friday’s Close

Two-Week Point Change

Year-to-Date Change

DJIA

17949.37

+314.21

+ 3.01%

S&P 500

2102.95

+31.73

+2.89%

NASDAQ

4800.34

+62.23

-(2.89)%

After touching an all-time low in pre-market trading Friday morning, 10-year Treasuries rebounded slightly on the day’s economic data. Investment-grade corporates also moved higher, mostly in response to the equity market. Month-end buying helped sustain the positive momentum. High-yields retraced their losses late in the period with both better-quality and more-volatile issues edging higher as buyers returned to the market. Municipal bonds were mostly positive as Congress passed legislation to set up an oversight board to help Puerto Rico restructure its tax-free debt.

Quote of the Week…

“I do not understand why the British government needs until October to decide whether to send the divorce letter to Brussels. It is not an amicable divorce, but it was also not an intimate love affair.”

Jean-Claude Juncker, president of the European Commission

Number of the Week…

$30 billion

The potential valuation of room-rental website AirBnB after a planned funding round and employee stock sale.

What Fund Architects has been doing…

So, it’s all Brexit all the time for the last couple of weeks. And to say the global market’s chaotic response to the Britain’s “Leave” vote was overblown would be an understatement. For our part, we didn’t change anything just because of the referendum. It was a big deal, of course, and lots of otherwise smart folks spent a lot of money trying to gain an edge on the outcome. But in the end it’s just the latest is an ongoing series of events that impact the markets. Since the Fund Architect process is designed to accommodate such short-term noise, Brexit made no difference to the way we allocate assets.

That’s not to say we haven’t been busy. It is, after all, the end of a quarter and the beginning of a month – the time when prefer to make trades based on our pricing model. While several interesting opportunities presented themselves, none, perhaps, is more interesting than the 10-year Treasury. This otherwise unremarkable security remains the story of the year.

You might remember we held an outsized position in the 10 government note earlier in the year. And what started out primarily as a hedge turned out to be a wildly successful trade, one we executed in April. After a brief respite, the investment has once again moved to the top of our models. As a result, we reallocated funds from U.S. mid-cap equities to 10-year Treasuries on Friday. The position will represent about 17.5% of our global portfolio.

That we’re able to use Treasuries in our equity lineup is, by the way, one of the things that separates Fund Architects from other money managers. We like it that fixed income of the sort, which currently has an almost perfect negative correlation to equites, allows us to earn a little money in a weak stock market without having to short stocks.

At the same time, we used the remaining cash from the mid-cap sale to buy global utilities. With yields continuing to fall around the world, utilities are producing more cash flow — a lot more cash flow — than just about any other equity. It’s reasonable to think that as yields keep coming down, utilities will keep their relative attractiveness.

The fixed income side also presented a few opportunities this period. On the sell side, we took a little profit out of positions in high-yield corporates and convertibles and reallocated preferred stock and (back) to emerging market sovereign debt. The preferred position is yielding almost 6% and should be nowhere near as volatile as other income investments. We see it as a good way to reduce risk and collect a good income as we go.

It’s likely the Brexit noise will reverberate for a while. In the short term, we’ll keep a close eye out for unusual opportunity. For the long term, we’ll stick to the Fund Architect process.

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.